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Sunday, February 12, 2006

Stock Market Envy: India Soars, China Slumps

This is a tale of two (actually three) stock markets.

China and India are both on the fast track to become the world's biggest economies, but you would never know it by following, let alone investing in, their respective stock markets. While India's market has performed brilliantly in recent years, and is attracting record flows of foreign capital, the opposite is true in China.

India's main stock market index hit a record high last week, closing above 10,000 points for the first time. Analysts said the milestone is a reflection of investor confidence in the Indian economy, which is growing by eight percent a year.

India's economic rival, China, has had an even bigger average growth rate of more than nine percent for the past few years, and is now the world's fourth biggest economy. But while India's stock market has soared in recent years, the opposite has happened in China.

Over the past five years, the Shanghai Stock Exchange index has slumped 40 percent, making it one of the world's poorest performers.

Robert Broadfoot, director of the Hong Kong firm Political and Economic Risk Consultancy, says the main reasons for the differences are the inadequacies of China's capital market.

Says Broadfoot: "China's market is much younger. It is dominated by state-owned companies, where the government still owns so many of the shares, that whenever the government tries to dispose of those shares, it depresses the market. So, it's a relatively illiquid market. India is an older market. It has got more private companies on. It has got more genuinely interesting companies on."

India's currency is more freely traded, and there are fewer restrictions on capital. That makes it easier for foreign and domestic investors to move money in and out of the stock market. On the other hand, restrictions on capital flow in China work against the development of a stock market there.

Another reason China lags behind, Broadfoot says, is that many Chinese simply have no confidence in their country's stock market.

"There is just a lack of trust," Broadfoot says, citing a poor regulatory climate. "The people that tend to invest in the market in China, which is not nearly as open as the Indian market, tend to be - it's insider trading. People are just wary of that now."

In contrast with Shanghai, the Hong Kong stock market is internationally respected. Hong Kong is the market of choice for Chinese companies in search of investor capital--and mainland Chinese investors in search of opportunity. The market is decades old and tightly regulated; and capital flows in and out of the city easily.

Though it reverted to Chinese sovereignty from British colonial rule in 1997, Hong Kong enjoys a high level of autonomy, compared to other Chinese cities. It also has a British-style, independent judiciary and well-established contract law.